IMF to US: Failure to Act on Debt Could Harm World Economy

Failure to raise the U.S. debt ceiling could damage not only the United States but the rest of the global economy, International Monetary Fund chief Christine Lagarde said on Thursday.

"It is 'mission-critical' that this be resolved as soon as possible," she said in a speech in Washington, ahead of the IMF and World Bank annual meetings next week.

She said growth in the United States has already been hurt by too much fiscal consolidation, and will be below 2 percent this year before rising by about 1 percentage point in 2014.

The U.S. Congress imposed a so-called sequester, or across the board government spending cuts, earlier this year after failing to agree on a broad budget package.

Turning to the rest of the world, Lagarde pointed to signs of progress in the euro zone and Japan, but said transitions to more stable growth may take a while.

She said the euro zone "came up for air" in the spring after six quarters of recession, and the economy should grow almost 1 percent next year.

Japan also seems to be having success with its massive monetary stimulus to boost the economy out of decades of deflation and lagging growth, boosting GDP by about 1 percent.

"Deflation is coming to an end and a newfound optimism is in the air," she said, adding that Japan must still implement a credible plan to bring down its debt and reform entitlements.

She said emerging markets have suffered since the U.S. Federal Reserve announced plans to eventually scale back its own monetary stimulus, which prompted capital outflows as investors bet on higher rates in advanced economies.

She said the turbulence could reduce GDP in major emerging markets by 0.5 to 1 percentage points.

Finally, she called on governments to better work together on reforming the financial sector, calling progress too slow, partly due to divergences among different countries. She pointed in particular to the "danger zone" of shadow banking, or the nonbanking sector that is not under formal regulation.

In the United States, shadow banking is twice the size of the banking sector, and in China half the credit given this year has come from shadow banking, she said.

"Putting this all together in a globalized world is a headache," she said about financial regulation. "And yet, it must be done - nothing less than global financial stability depends on it."